How to Calculate Inventory Weighted Average Cost

As a business owner, knowing how much inventory you have in real time is crucial. Knowing the total market value of the inventory materials is equally important. This knowledge is when you decide what to stock up on. It will also help you to determine what your bestselling items are. There are several variables in calculating the cost of your inventory. Examples of such variables include the cost of product manufacture, demand for the product, and cost of the products you sell. With so many variables at play, evaluating your inventory can be an overwhelming task. Fortunately, there are many methods to calculate this inventory used in eCommerce. Let us look at one such method.

Inventory Weighted Average — Introduction

One of the methods to calculate the current value of your inventory is called inventory weighted average. It is also otherwise known as weighted average cost or WAC. In this method, the weighted average is used to determine how much money should be used for inventory and cost of goods sold or COGS. To find this cost, find the average cost of a piece of the product in the inventory. The inventory weighted average method is termed valid by generally accepted accounting principles or GAAP. This method is also recognized by the International Financial Reporting Standards or IFRS. However, this method involves in-depth calculation with a formula. The calculation of this method also requires your inventory data to be accurate.

Sometimes, businesses pay different costs when they order inventory of their product. This price difference is more common when the products that the businesses are not always available in the market. This discrepancy in pricing might affect how the individual cost of the product is calculated.

Inventory Weighted Average — When to Use

An ideal time to use weighted average cost is when the business owner is required to count their inventory thoroughly physically. This process ensures that the items listed and their quantity are available in the inventory. Performing this through count helps the business owner track cost change activities accurately. This weighted average cost is used when business owners are required to assign an average cost to the individual products in their inventory. One of the reasons for assigning an average cost could be that certain products in the inventory are similar. Alternatively, these products could be challenging or impossible to calculate separately as individual product items.

Suppose a business is sought after and its products are sold out regularly. In that case, they might be required to do an average calculation as their product removal and replenishment will be done frequently. In another scenario, if the business owner cannot separate the new stock of the product from an existing one, they will need to calculate the average instead of the actual inventory cost.

Inventory Weighted Average — Calculation

The formula to calculate the weighted average cost is simple. Take the total price of the products purchased and divide that by the number of units of the product that are available for sale. Let’s look at the components one after another. The total price of the products purchased is the cost of goods sold or COGS. It is the original value of your inventory and all the purchases that you made. The units of product available for sale is the total number of products you currently have in the inventory.

The business owners might use the period or perpetual inventory systems to calculate the weighted average cost. How much cost you allocate to the inventory will vary based on which one of the following inventory systems you choose:

• In the periodic system of calculating the inventory cost, business owners calculate the inventory count at the end of a period. They then apply the cost of the product to calculate the final cost of the inventory. The business owners then add this final cost of the inventory to the initial price and purchases made to the inventory for a specific period. This gives them a periodic calculation.

• The weighted average cost method in the perpetual inventory system is called the moving average cost method. The reason for the coinage of this specific term is that in this method, the business owners regularly track their product inventory and cost of goods sold or COGS. When they buy new product material, they immediately add it to their product inventory. The average cost price is calculated after every sale. To calculate the inventory cost in the perpetual inventory system, calculate the total price of the product you currently have and divide that by the number of units of the product you have.

Conclusion:

Apart from the weighted average cost, there are other methods of calculating the inventory cost, such as first-in, first-out, or FIFO; last-in, first-out, or LIFO; and specific identification methods. While weighted average cost is a method to calculate the current value of your inventory, it might not be the ideal method for your business. If you are confused about which inventory calculation method suits your business the best, research on all the methods and weigh out the advantages and disadvantages of each method based on your type of business. As a business owner, you must choose a calculation method that is suitable for your business and that you can calculate year long.

About XPDEL:

XPDEL is not another 3PL supply chain and logistics provider. We help eCommerce brands accelerate their growth, empowering them with multi-channel fulfillment, whether shipping directly to consumers, delivering to businesses, or selling through retail stores. Powered by advanced technology and led by industry experts, we thrive on data and insights for making smart business decisions.